How microfinance disappointed the developing world

Author

Associate Professor of Strategy and Policy, Judge Business School at University of Cambridge

Disclosure statement

Kamal Munir does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.

In 1976, a small experiment was conducted in the poverty-stricken and flood ravaged Bangladeshi village of Jobra. Professor Muhammad Yunus, a lecturer of Economics at Chittagong University visited the village and upon seeing the desperate poverty there he decided to lend about $27 (free of interest) as working capital to a few women he met there. To his surprise, the women used the money productively in their modest commercial enterprises and repaid the loan with thanks. This small experiment was to become the basis for a global revolution popularly known as microfinance.

As the new millennium arrived, micro credit had come to be recognised as the ultimate panacea for endemic poverty. In 2005 the UN Secretary General Kofi Annan said it was a critical anti-poverty tool, emancipating women and empowering the poor and their communities. Yunus claimed that thanks to micro credit the next generation will only find poverty in museums.

World leaders cheered in unison, overjoyed at the discovery of a market-based mechanism for eradicating poverty. Thousands of NGOs took up micro-lending to poor communities with billions of dollars in development aid flowing through them. The microfinance revolution had well and truly arrived. The UN declared 2005 as the year of microfinance and next year a Nobel Peace Prize was awarded to Yunus and Grameen Bank for “efforts to create economic and social development from below.”

Within five years, however, the gloss has started to come off. Long-standing claims of poverty alleviation and female empowerment came to be challenged. Reports of usurious interest rates being charged to desperate borrowers came to light amidst mounting criticism of the high-handed tactics employed by loan officers to collect monthly instalments. Collective defaults by entire villages were reported around the world. Most disturbingly, in the Indian state of Andhra Pradesh, a hotbed of microfinance lending, dozens of suicides occurred among borrowers under pressure from large micro-lenders, forcing the state to clamp down on the exorbitant interest rates.

Recent studies have found microfinance to have had zero impact on poverty alleviation. While it still has a big presence in the developing world, and undoubtedly helps some entrepreneurs find their feet, the hopes and aspirations that it once aroused are no more.

Yes, many grassroots organisations are doing a world of good through embedding themselves deeply within the communities they hope to serve. But the myth surrounding the minimalist model of microfinance favoured by international agencies and private investors, which involves only lending at the “true cost of capital” with no other “intervention” has exploded rather spectacularly.

Here is how the minimalist model unravelled:

Micro-credit could indeed provide a lifeline for desperate borrowers, if it operated at a small scale and with subsidised interest rates. To some borrowers it could provide a crutch even at relatively high interest rates, saving them from the clutches of moneylenders.

But given the huge increases in living costs and the reduced role of governments, especially with respect to healthcare and education, micro credit was never going to be able to stem the tide of poverty. Healthcare is perhaps the number one route to bankruptcy among the poor in many developing countries and education takes an ever-increasing proportion of their income.

Painting all the women in the world as heroic entrepreneurs doesn’t actually make them so. They are heroic all right, given the struggle they lead against brutal poverty – but entrepreneurial ventures have always had a high mortality rate. And there aren’t that many which can deliver the kind of returns one requires to be able to pay back interest rates in excess of 40%. Given that much of the loaned money is actually used for consumption, the chances of getting into debt are always high.

Realising that poverty alleviation was an unsustainable and unachievable goal, the micro-credit industry shifted the goal posts. “Financial inclusion” was the new aspiration, which in practice meant access to credit, insurance and other financial products. This was based on the old Milton Friedman claim that the only difference between the poor and the rich was access to capital.

The term micro-credit became microfinance and poverty alleviation quietly moved out of the spotlight. The fact that most borrowers were using the loans for consumption rather than production was not taken as a failure to achieve the original goal either. Instead, this “consumption smoothing” was celebrated as another achievement.

Microfinance then had two different realities. One was the global celebration of this market-based model for poverty alleviation. The other was the cruel reality of many borrowers caught up in debt cycles and struggling against an oppressive neoliberal world order where the proportion of incomes spent on health, education and food kept going up.

Either way, it presented an opportunity for investors to “do well by doing good”. Once development agencies and multilateral institutions had paved the way, global investors piled in. Sitting far away in New York and other capitals of the financial world, they were attracted by the tales woven by microfinance providers looking to tap into global equity markets, tales of helping the poor and making a buck at the same time.

With international capital, however, came unprecedented pressure for growth and quarterly profits. Those providers who tapped into the equity markets responded by seeking out more borrowers, and then when defaults loomed they tightened the screws to keep things on track. They devised elaborate public shaming rituals and used these ruthlessly to destroy borrowers’ social capital. Even Yunus disapproved, accusing them of making profits off the back of the poorest, neediest members of society.

If the minimalist model, fuelled by global capital, survives today it is thanks primarily to desperate poverty that engulfs the world and to bigger loans that target the not-so-poor. Growing polarisation of society that raises the cost of living for the poor, along with wholesale privatisation of social welfare institutions, is putting increasing pressure on the poor.

At best, minimalist microfinance provides a bandage where a major operation is needed, and at worst, it deepens the wounds. Socially embedded microfinance institutions that organise entrepreneurs, provide them with training and then deploy them in larger ventures are much more effective though high cost propositions. Interest-free microfinance, based on charity, similarly offers much greater relief. Ultimately, however, both are largely helpless in face of the neoliberal onslaught.